From Construction to Refinancing, Capital for Hotels is Pouring In
Damian Ghigliotty Sept. 30, 2013, 10:45 a.m.
When New York’s largest independent hotel developer and owner, BD Hotels, began exploring sources of capital this year for its latest projects, the company’s co-founders decided to diversify their approach to construction financing due to a growing of number of potential lenders.
Richard Born and Ira Drukier, who partnered in 1986 and now own and operate 25 hotels in New York, including the Maritime Hotel in Chelsea and the Bowery Hotel in the East Village, are in talks with a foreign investor to provide secondary capital for an upcoming development in Midtown, while sticking with a traditional bank for their first construction loan.
“There’s just so much money being designated for New York City hospitality now,” Dr. Born, who did four years of surgical residency before going into the real estate business, told Mortgage Observer. “Especially with all of the foreign sources coming in.”
New York, the country’s premier hotel market, is a ripe financing field for developers with enough experience, brand recognition and equity of their own. At the same time, new entrants coming into the hospitality financing market and the return of traditional lenders have spurred more hotel deals throughout the United States. That increase has most recently led to a major uptick in hotel financing in secondary markets, from New Orleans to Cincinnati.
Hotel loans made up about $5.7 billion of multi-borrower securitizations in the first three quarters of 2013, more than double the $2.5 billion of hotel loans contributed to conduits in the same time period last year, a recent study from Cushman & Wakefield shows. Overall, the number of active lenders in the hotel sector today has increased by about 20 percent in the past year, said Ernest Lee, director in the global hospitality group in the equity, debt and structured finance division at the New York-based real estate services firm.
On top of growing interest from alternative lenders and foreign investors, many regional and national U.S. loan originators and brokerage firms are expanding their hotel financing platforms in 2013. “There is a tremendous increase in appetite for hospitality lending,” said Jared Kelso, managing director of Cushman & Wakefield’s global hospitality group, which arranges debt and equity for hotel owners. “We’ve seen the market for transitional assets, or bridge lending, almost double in size, which is incredibly important for the hotel industry. On top of that, we’ve seen over 10 new whole loan platforms for transitional assets enter the hospitality space this year alone.”
In April, Mr. Kelso’s group closed a $55 million floating-rate acquisition loan from Natixis Real Estate Capital for the Hyatt Union Square hotel at 134 Fourth Avenue, among other hotel deals they could not discuss publicly. Mr. Kelso noted that hotel construction financing from banks and other lenders is also picking up as many of them are being pushed into the hotel space for better yields due to “intense competition to lend on other asset classes, such as Class A office buildings.”
But even as capital has started to flow into hotels again, borrowing is still not as easy as it was prior to the financial crisis, Dr. Born said. “The debt market today is clearly head and shoulders above where it was in 2009 when there was no debt market,” he explained. “But it is still not as frothy as it was at the peak of the market in 2007.
Michael Nash, chief investment officer of Blackstone Real Estate Debt Strategies, echoed that sentiment, adding that large construction loans are still a challenge for many developers to get. “New York as an exception has actually had a decent amount of supply, but in other major markets it’s harder to build new hotels. The numbers are hard to justify,” Mr. Nash said. “The financing on the construction side is still virtually impossible, so it makes it easier for us to pick and choose our spots.”
Hotels, by and large, are considered the riskiest real estate asset class to lend on due to their operating models. The average hotel’s occupants move in and out on a nightly to weekly basis, making each month’s income that much more uncertain and upkeep that much more costly. Even in top markets where occupancy remains high, significant capital is required every four to five years to keep a hotel’s maintenance up to standard, according to the hotel developers and financers Mortgage Observer spoke to.
“It’s an extremely variable model and is subject to peaks and valleys more than any other real estate asset class,” Mr. Kelso said. “So the net operating income available to pay debt service can go from three times debt service coverage to a fraction of that in the space of a year.”
As a result, transitional floating-rate capital has always been a vital component of hotel financing. Before the market collapsed in 2008, there were a large number of domestic banks and international lenders providing floating-rate loans to the hospitality industry. Many of those lenders—Capmark Financial Group and Hypo Real Estate Holding among them—shut down their financing platforms in 2009, making it that much harder for developers to secure loans for construction, as well as for less risky upgrading and refinancing, Mr. Kelso noted. As commercial real estate lending as a whole started to pick back up in 2011, fixed-rate capital available for stable hotels came back first, he said.
The pool of those willing to finance hotel projects in October includes private equity, local, regional and national banks, life insurance companies and both floating-rate and fixed-rate CMBS lenders, as well as mortgage REITs, debt funds and foreign investors. As of late 2013, about 85 percent of the lenders that were active in the hotel financing space prior to the downturn have returned, hotel financing experts say.
In response to increased hotel-financing activity and increased demand for brokers to help arrange some of those deals, Chicago-based Jones Lang LaSalle in mid-September announced the expansion of its national Hotel Investment Banking Platform under the company’s Hotels & Hospitality Group. The team has closed about $3.5 billion in hotel deals in the past 24 months and currently has about $1.5 billion in the market with 33 transactions in the works around the country.
This year, the Jones Lang LaSalle hotel investment banking team, which includes co-heads Matt Comfort and Jeffrey Davis and executive vice presidents Kevin Davis and Bill Grice, closed several big acquisition, construction and refinancing deals. These include a recent $37.5 million loan from Morgan Stanley to refinance the Florida Hotel and Conference Center in Orlando, Fla., and a $120 million loan from AIG to refinance the Hilton Americas in Houston, Texas, according to two people familiar with the transactions. The Jones Lang LaSalle executives declined to speak about specific deals while providing an overview of the latest trends in the market.
Mr. Comfort, who was recently appointed managing director to take on a larger role, said he and his colleagues have seen the largest uptick in new hotel construction loans in Austin, Nashville and New York in the past 18 months, as well as a sizable increase in loans for hotel renovations in New Orleans, Miami and Chicago.
“The premise of everything is operating performance, which has been remarkably strong and continues to be strong in most of the markets out there,” Mr. Comfort, who has arranged nearly $5 billion in hotel financing since 2010, told Mortgage Observer during a recent interview with his team. “When you look closely at some of the trends, you can see that historically, whenever there has been a downturn, the recovery from that downturn, in terms of revenue per available room, exceeds the previous peak.”
He added that the U.S. hotel market as a whole has yet to match the previous RevPAR peak prior to 2008, a strong indication that there are still growth opportunities in most of the cities when it comes occupancy rates and bottom-line revenue. “When you look at owners of assets that are up and running and have consistent in-place cash flow, robust debt markets in a lot of ways have induced them to become borrowers,” Mr. Comfort said. “With existing hotel properties, we’re seeing that low interest rates and available capital are spurring on more refinancing, as well as more acquisition financing.”
As local, regional and domestic banks have reopened their lending programs for hotels, more competition has come into secondary and tertiary markets as well, Mr. Comfort noted. That crowding has pushed some of the pioneering alternative high-yield lenders, such as mortgage REITs and debt funds—the first to start lending on hotels after the market shutdown—into new territories, he said.
The alternative lenders that were charging between 8 and 10 percent interest on hotel deals in 2009, when few institutions were willing to lend, are now being forced to charge between 4 and 5 percent, said Mr. Davis, who joined the Jones Lang LaSalle hotel investment banking team this year. That has led to further yield spread compression, he noted.
Big institutional lenders, including national and “super regional banks,” such as M&T Bank, are now providing loans for the greater portion of hotel deals in top markets, including New York and San Francisco, according to Mr. Comfort of Jones Lang LaSalle and Mr. Kelso of Cushman & Wakefield.
“The market for cash-flowing hotels really started to open up in late 2010 and in early 2011,” said Mr. Comfort, who frequently works with private equity firms, including Blackstone Group and Apollo Global Management, as well as hospitality REITs such as Ashford Hospitality Trust and Hersha Hospitality Trust.
“Again, the high-yield lenders who got into the market early were followed by the lower cost of capital lenders, starting with CMBS lenders and then insurance companies and banks,” he said. “In some ways, it’s similar to the demographic changes in New York where you have your cool neighborhoods like Williamsburg that start off with pioneering artists and entrepreneurs and then eventually the finance guys come in and take over.”
Blackstone, which has been a major presence in hotel financing throughout the downturn and after, has committed about 35 percent of its $3.5 billion BREDS fund I and about 23 percent of its $3.5 billion BREDS fund II to hotel lending this year.
In May, Mr. Nash and his colleagues at the New York-based private equity investment firm originated a $229 million senior mezzanine loan as part of a $1.3 billion refinancing of a large limited-service hotel pool owned by Tharaldson Hospitality Management. And Blackstone is now working with a private opportunity fund to refinance a prominent Midtown hotel that the fund purchased earlier this year, a person familiar with the negotiations said.
“Of course, we like major markets, but we also like select service markets thematically to buy or lend into, because those cash flows are a little less volatile,” Mr. Nash said. “The only thing you worry about in secondary markets is that it’s always easier to build competitive new supply, so that’s the thing that weighs over you constantly. In the major markets, where it’s hard to build anything, hotel supply additions are few and far between.”
Even as the pool of hotel lenders in New York has started to overflow, Dr. Born and Mr. Drukier have mostly worked with a select handful of institutional lenders to finance their projects. In 2011, the developers closed on a $46 million construction loan from Wells Fargo for their hotel in the works at 180 Ludlow Street.
Now with the addition of so many lending sources on Manhattan hotels, while beneficial to borrowers, overcrowding could become the next problem, Dr. Born noted. “New York probably has more hotels in the works than it needs,” he said. “The tourism business in New York is very good, and I think it will continue to be good for a long period of time. But I also think the level of development is going to outpace growth materially over the next couple of years.”
When asked about the downside of the latest hotel financing resurgence, Mr. Comfort noted that now is too early to tell, since hotels are generally the first to go in tough times and the first to pop back up when liquidity returns to the market. “We haven’t seen a lot go wrong yet this cycle,” he said. “We’re at a point where operating performance continues to improve and there is a new supply of lending coming in, so troubled loans are something we likely won’t see for a few years.”